Making Cents in Penny Stocks

If it rained pennies from heaven, as Bing Crosby once sang, a few storms would sure do our bank accounts some good. But as Fools, we know that penny stocks are dangerous to our financial situation. Because the world of penny stocks is full of shysters peddling manipulation and deceit, investors often have a hard time separating the few good companies residing there from the multitude that are best ignored.

Although many people like investing in penny stocks, in the belief that such stocks have a better chance of increasing many times in value, nothing says that a $20 stock can't double, triple, or quadruple in value just as easily as a cheaper one can. Considering that a cheap stock may be cheap for a very good reason, there's ample evidence to suggest that higher-priced stocks may actually have a better chance of going up than cheap ones do.

Still, many investors dabble at the low end of the stock-price spectrum. At Motley Fool CAPS, we note the investors who, more than half the time, rate stocks trading in the single digits, and we give them a saucy name -- "Pennies." Believe it or not, you'll find some of the best CAPS All-Star investors among them.

Pinching pennies
This week, we'll look at some of the low-priced investments these All-Stars have praised or panned. If the best investors who regularly scan this end of the market have singled out these companies, we might want to turn our umbrellas upside-down -- or maybe run for cover instead!

All-Stars believe that these low-priced stocks will outperform the market:

And here's a list of those that the All-Stars think will underperform:

As we delve into the low-priced arena, we find that most of the stocks here have not been generating much investor support. CAPS players have rated almost all of them at just one or two stars. Yet cell-phone music software maker Smith Micro and oil and gas industry services provider Newpark Resources look to have investor support, with their high ratings.

Despite such support, Smith Micro's stock has fallen by half since it released a weak earnings report at the end of last month, in which costs rose even as revenue increased. It's got a strong relationship with Verizon (NYSE:VZ). However, since Verizon brings in some 67% of the company's revenue, the wireless provider poses potential risks should it slow or halt spending. But with Smith Micro's new multimedia software being introduced for smartphones, Fools are looking for the company to rebound.

More than 700 CAPS investors have rated Smith Micro, with 97% believing it will ultimately outperform the market. CAPS player aprato64 believes the sell-off has been overplayed and that the company, with a strong balance sheet, should be able to prosper:

Stock has been ridiculously beaten down since Q3 '07 earnings. They have no debt, millions in cash which they can use to acquire complementary companies without financing. Strong relationship with Verizon. Music is not the future of this company ... it's the software, particularly StuffIt Wireless. Good [acquisition] strategy. I really believe this will be an earnings monster. Disclosure: I own shares of SMSI.

Another CAPS player, Ebbs23, sees Smith Micro's multimedia capabilities as the cornerstone of driving future technology:

Cell phones aren't just for talking anymore. New technology/gadgetry is constantly evolving and being added to phones. Technology such as MP3 capability, cameras, video, [hard drive] storage etc. SMSI helps make all of that happen.

Make some change
There you have it -- some of the top CAPS investors' reasons why these "penny stocks" may or may not be a good investment. What do you think? Should we fill up the change jar with them, or ignore 'em like a discarded coin on the street? Consult our free Motley Fool CAPS investor-intelligence community, where your opinion makes just as much cents -- er, sense -- as any other investor's.

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